wsj wsj live marketwatch barron's djx more search · amazon’s profits are soaring: why that...
TRANSCRIPT
06.05.17, 09*06Amazonʼs Profits Are Soaring: Why That Could Be Bad for the Stock - Barron's
Page 1 of 5http://www.barrons.com/articles/amazons-profits-are-soaring-why-that-could-be-bad-for-the-stock-1494048078?mod=BOL_hp_highlight_2
WSJ WSJ LIVE MARKETWATCH BARRON'S DJX MORE
ASIA EDITION
U.S. EDITIONWelcome, Heinz Customer Center Logout
FEATURE
Amazon’s Profits Are Soaring: Why That Could Be Bad for theStockAs Amazon steamrolls traditional retailers, it must avoid becoming too profitable. Shares could exceed $1,000 by summer and gain 20% in ayear.
Updated May 6, 2017 1:46 a.m. ET
As Amazon.com stock nears its 20th birthday, its long-term holders have alreadyenjoyed many happy returns. The price has soared from $2 to $934, adjusted for splits,since the first day of trading on May 15, 1997. That puts Amazon’s market value at$450 billion, making it the fourth-largest U.S. company, behind Apple (ticker: AAPL),Alphabet (GOOGL), and Microsoft (MSFT). No company has ever reached such a sizewith so little in cumulative profit—about $5 billion since going public. Alphabet, bycomparison, has earned $90 billion over just the past five years. Apple has made morethan that over the past two years. Amazon’s ascent has made fuddy-duddies out ofinvestors who pay attention to such things. Barron’s went negative on the shares with ahyperbolic cover line during the dot-com stock bubble (“Amazon.bomb,” May 31, 1999).Less than two years later, the stock had indeed fallen from nearly $60 to below $10,split-adjusted. But our call to buy at the bottom, or on the way back up, was deafeninglyabsent. (See sidebar: “The Amazoning of American Retail.”
For some, Amazon’s stock market success calls into question whether profit is still arelevant measure for growth investors, or even a worthy goal for growing companies.But for now, the outlook for the stock can be summed up with one word: higher.
Pari Dukovic/Trunk Archive
Most Popular
How Did That Happen?!?! S&P 500 HitsNews High (and We Have No Idea Why)
1.
The 5 Biggest Credit-Card Mistakes2.Fitbit’s Pain Is Apple’s Gain3.Google May Need an Acquisition to CatchAmazon, Microsoft, Says Goldman
4.
Apple, Qualcomm: A Messy Marriage5.SEE FULL LIST
Latest Market Videos
Barron's Buzz:Amazon Stock at20: Now What?
1
The Future is2
By JACK HOUGH
Email Print 0 Comments Order Reprints
HOME MAGAZINE DAILY INVESTING IDEAS ADVISOR CENTER MARKET DATA PENTA BARRON'S NEXT
News, Quotes, Companies, Videos SEARCH
06.05.17, 09*06Amazonʼs Profits Are Soaring: Why That Could Be Bad for the Stock - Barron's
Page 2 of 5http://www.barrons.com/articles/amazons-profits-are-soaring-why-that-could-be-bad-for-the-stock-1494048078?mod=BOL_hp_highlight_2
We think Amazon shares (AMZN) could reach $1,000 by summer and $1,100 within ayear, for a gain of close to 20%, which, along the way, could make Amazon founder JeffBezos the world’s wealthiest person. While earnings estimates have been sliding of lateas the company ramps up spending, if history repeats, that means revenue growth isabout to reaccelerate, leading investors to conclude that the cash was well spent, andthat the shares are worth more.
Over the next few years, the operating environment will remain brutal for Amazon’svictims, most recently clothing stores, and will become more challenging for consumer-goods companies that rely on brand-building and shelf space, rather than innovation,for pricing power. Amazon could even kick Alphabet in the shins in internet search. Atthe same time, there will be companies that, like remoras that attach themselves tosharks and feed on scraps, benefit from the bloodletting.
By the end of the decade, Amazon’s profits will balloon, not because Bezos wants themto, but because it will be unavoidable, as revenues overwhelm costs and investments.That’s the tricky part for long-term investors. A steady ramping of profits—or Bezos’preferred measure, free cash flow—lends itself to arithmetic, which is a lot less excitingthan open-ended potential and narratives about market dominance. The next downturnfor Amazon stock might not come when profits disappoint, but when they become tooobvious. Forget Amazon.bomb, but Amazon.boring is a long-term risk.
TWENTY YEARS AGO, Amazon was a fairly easy company to describe. It sold booksonline, and was considering a move into music and videos, although in his legendaryfirst letter to shareholders, Bezos made only limited mention of products, writing morebroadly about online commerce, the need for sustained investment in systems andinfrastructure, and the challenge of prioritizing those investments.
Today, Amazon remains, in part, a store. It recently cracked the top 10 list of worldwideretailers by revenue, and is still expanding sales faster than 20% a year, versus single-digit growth or declines for the others. But of course, the company is much more thanthat. It is a shopping club, Prime, with an estimated 80 million members who skewyoung and well-off. It is a vast marketplace for third-party sellers, whose data help tellAmazon which products to poach for its store, or even to begin making itself. It’s anearly leader in cloud computing for hire, where profit margins have proven so rich thatMicrosoft, Alphabet and others have piled in. It’s an entertainment company that thisyear is expected to spend more on content than do NBC and HBO—and that’s theirmain business, not a sideline. It makes gadgets, like the Kindle reader, Fire TV, andEcho voice assistant. And it’s a recent entrant into online advertising, which shouldmake Alphabet nervous. That’s because while Google is still far and away the searchleader, the most lucrative searches are those for products, two-thirds of which start onAmazon.
IN SOME WAYS, AMAZON IS LIKE Berkshire Hathaway, but with better returns.Berkshire sells insurance, where premium payments roll in long before claims are paid,allowing CEO Warren Buffett to invest other people’s capital free of charge. Amazonsells inventory so quickly that it often collects from customers before it pays suppliers,creating an ongoing free float of cash to use.
Almost Here
Tesla Makes ItEasier to GetService
3
06.05.17, 09*06Amazonʼs Profits Are Soaring: Why That Could Be Bad for the Stock - Barron's
Page 3 of 5http://www.barrons.com/articles/amazons-profits-are-soaring-why-that-could-be-bad-for-the-stock-1494048078?mod=BOL_hp_highlight_2
(To see larger size image of chart, click here .)
Last month, in his latest shareholder letter, Bezos continued to focus less on productsthan on investment, especially in artificial intelligence and machine learning. Thatspending will power better merchandise decisions for Amazon’s store, and make Alexa,the voice of Echo, more lifelike; A.I. wizardry also can be resold to cloud-computingcustomers.
By double-dipping like that on its inventions, Amazon raises the potential payoff of itsinvestments, which reduces risk. Its cloud infrastructure, for example, can cut operatingcosts for its own video-streaming business, while turning rival Netflix (NFLX) into apaying customer. The company further controls risk by moving quickly past flops. ItsFire Phone, launched in the summer of 2014, was laid to rest barely a year later.Microsoft, in comparison, stuck with its unloved Zune music player for more than fiveyears.
CORPORATE INVESTMENTS are meant to build profits, or at least, that’s the way ittraditionally has worked. For Amazon, a familiar pattern is afoot. Last year, investmentsurged 47%, to $6.7 billion, and forecasts for this year’s spending have been rising.Profit is expected to climb 40%, to $3.3 billion, far more than the company has everearned. But just last fall, investors were predicting $5.3 billion in profit this year.
Shareholders aren’t worried. “I don’t think Amazon is a company that will ever go intoharvest mode,” says John Ettinger, a portfolio manager at Federated Investors, and anAmazon bull. “They’re always going to want to experiment.” In Amazon’s latest quarterlyreport, Bezos called out spending in India, where Amazon is quickly adding to its Primeselection, as well as on television shows and its order-fulfillment network.
All of this is promising for investors. When Goldman Sachs analyst Heath Terry raisedhis price target on the stock late last month, he noted Wall Street tends tounderestimate how Amazon’s investment spurts lead to a pickup in revenue growth.Top-line forecasts have been rising. By next year, Amazon could top $200 billion inrevenue, ranking it among the top five U.S. companies. Historically, Terry points out,Amazon stock has performed best during stretches that have started with a jump inspending.
AMAZON’S EXAMPLE MIGHT be helping to change investment analysis, and evenstock performance. Baruch Lev, an accounting professor at New York University, hasdocumented a long decline in the relationship between stock returns and upsideearnings surprises, or even earnings growth. Traditional accounting, he says, fails tocapture how spending on things like research and development adds to intangibleassets that can power growth for years to come. Investors are left sifting for clues in
06.05.17, 09*06Amazonʼs Profits Are Soaring: Why That Could Be Bad for the Stock - Barron's
Page 4 of 5http://www.barrons.com/articles/amazons-profits-are-soaring-why-that-could-be-bad-for-the-stock-1494048078?mod=BOL_hp_highlight_2
More From Barron’s
Is the 8-Year-Old Bull Market Near Its End?
Tech Today: Buffett Dumps IBM, OLED Soars,Arista, AAOI Rising
We Have a Big ‘Crush’ on This Cheap EnergyPlay
measures that don’t necessarily show up in reports.
In a recent conversation with Barron’s, Lev pointed to one such clue for Amazon:Though it holds fewer patents than Alphabet, its patents are cited more often in filingsby others, suggesting they’re more valuable.
Amazon has changed the relationshipbetween companies and investors byreplacing profit with growth and vision,according to a colleague of Lev’s, ScottGalloway, an NYU marketing professorand founder of digital-research platformL2. “Loss is the new black,” he toldattendees at a conference last month,
citing the willingness of upstarts like Uber to lose steep and growing sums. “You canargue this might not end well…but the reality is retail investors love this model.”
To Galloway, Amazon is not only dismantling retail, as evidenced by a sharp recent risein store closings and bankruptcies, it also poses a long-term threat to brands. Brandsserve as a signal to product quality, which manufacturers reinforce through advertising,allowing them to charge premium prices. Amazon can replace the role of brands byusing one of its earliest innovations, unvarnished user reviews, combined with itssearch algorithms. The result is a better quality signal without the premium pricing, thusweakening the value of established brands.
IRONICALLY, NOW THAT Amazon has convinced the investing public of theunimportance of profits, its earnings are on the verge of soaring. Within five years, theycould total $20 billion a year, a level only six U.S. companies are expected to reach thisyear. True enough, those forecasts have a way of coming down over time, but unlessAmazon’s next venture is launching a small nation-state, it will have a hard timeinvesting away such a sum, not to mention its free cash flow, which is much higher. Infive years, free cash flow is projected to reach $36 billion a year. That’s enough moneyto make Amazon’s current market value look almost modest, at less than 13 times 2021free cash flow.
Of course, investors who buy today will want to see peppy stock gains between nowand then. If Amazon’s market value swells to $1 trillion within five years, and if that2021 consensus holds, it will trade at 28 times free cash flow—a full price, but not anutty one.
The pesky thing about profits and free cash flow is that once they are rich and rising,investors tend to get hooked, and they can begin asking more meddlesome questionsabout the latest investment spree, stock compensation, next year’s bottom-line growth,and so on. Some are boorish enough to begin demanding dividends.
It’s unclear how the world’s biggest startup will handle that transition when it comes. Inthe meantime, Amazon stock at $934 looks poised for more youthful gains.
Email: [email protected]
Like Barron’s on Facebook
Follow Barron’s on Twitter
Latest in Feature
Tesla Could Lose the Love; Ford, GM Might Gain It1.The Amazoning of American Retail2.Novartis Has the Right Prescription for Profits3.
Email Print 0 Comments Order Reprints
06.05.17, 09*06Amazonʼs Profits Are Soaring: Why That Could Be Bad for the Stock - Barron's
Page 5 of 5http://www.barrons.com/articles/amazons-profits-are-soaring-why-that-could-be-bad-for-the-stock-1494048078?mod=BOL_hp_highlight_2
Sponsored Results
1. Stocks To Invest In
2. Best Penny Stocks To Buy
3. Best Biotech Stock Picks
4. Best Stocks Online
5. Free Amazon Coupons
6. Most Popular Books
7. Amazon River
8. Acai Berry
Powered by Livefyre
The Trump Tax Plan: The Good, Bad, and Dumb4.Wall Street Pros Are Bullish on 2017 But See Recession Late NextYear
5.
NEWEST OLDEST
31 PEOPLE LISTENING
Barron'sFacebookTwitter Google+LinkedInYouTubeRSS Feed AppStore Google Play
Return to Top
Customer Service
Customer Center
Contact Us
Live Help
Create an Account
Subscribe to Barron's
Magazine Subscribers:Activate Your Digital Access
About Barrons.com
Advertising
Masthead
Privacy Policy
Updated Cookie Policy
Data Policy
Copyright Policy
Subscriber Agreement& Terms of Use
Your Ad Choices
Community Guidelines
Also From Barron's
Conferences
Reprints
Classifieds
College Program
Find a Broker
Barron's in Japanese
Tools & Services
Mobile Site
Email Newsletters
Barron's on iPad/iPhone
Barron's on Android
Watchlist
Video
Annual Reports
StockGrader
Barron's 400
Economic Calendar
Stock & Mutual Fund Listings
Commodities, Options& Annuities Listings
Fund Prospectuses
Copyright ©2017 Dow Jones & Company, Inc. All Rights Reserved.
0 comments
+ Follow+ Follow Share Post comment as...